IndyMac's shuffle ran over depositors

After selling her Orange County home, Cheryl Hodgson parked an escrow check for about $360,000 with IndyMac Bancorp.

Less than a month later, the Pasadena-based thrift was seized by the federal government -- and Hodgson lost $130,000.

"I looked around at the interest rates and saw that IndyMac was offering a really good rate," Hodgson said. "You would think someone at the bank could have explained to me that I was putting in money well above the insurance limit."

Although accounts at the time were insured only up to $100,000, Hodgson ended up recovering $230,000 because the Federal Deposit Insurance Corp. covered half of uninsured deposits.

Still, she was among an estimated 10,000 depositors who lost $270 million in deposits when IndyMac collapsed under the weight of mortgage loan defaults.

These losses might have been prevented had federal regulators done their jobs in overseeing IndyMac, a government report this week determined.

The report from the Treasury Department's inspector general excoriated the Office of Thrift Supervision for ignoring warning signs that IndyMac's loan portfolio was quicksand, costing the Federal Deposit Insurance Corp. $10.7 billion.

The report casts a shadow over both the OTS and its director, John M. Reich, who stepped down Friday.

"John Reich's reign was catastrophic to the OTS, the FDIC and the uninsured depositors in particular," said Richard Newsom, a retired FDIC and California state bank examiner, referring to the failures of IndyMac, Washington Mutual Bank and other institutions. Reich declined to comment for this story. OTS officials said that Reich, after taking office in 2005, increased the number of bank examiners and worked hard to make sure that struggling thrifts recovered their footing and stayed in business.

The Times found that those efforts were too little, too late in the case of IndyMac.

* OTS officials became concerned about IndyMac's strength in early 2007, said Timothy T. Ward, OTS Deputy Director for Examinations, Supervision and Consumer Protection. He said officials moved up a scheduled bank exam for IndyMac, but the review did not begin until January 2008.

* IndyMac's top managers tried to secure OTS approval of another questionable accounting maneuver in the company's final months, according to company e-mails, before persuading the agency to allow it to backdate a capital infusion, a move that is now the subject of a federal investigation.

* The OTS ignored concerns from the FDIC that the bank was using recklessly high interest rates to lure in new deposits to cover its losses, interviews and documents show.

IndyMac prospered during the real estate boom, which fueled demand for its so-called alt-A mortgages, loans that it granted to borrowers with clean credit but with little or no documentation of their income. It would then sell those loans to other banks or investors through bundled securities.

As the real estate market collapsed, however, IndyMac was stuck with loans it couldn't sell.

"The secondary market for mortgage-backed securities had dried up," said Ward.

Ward said the review the agency conducted in January 2008 resulted in a downgrade of IndyMac's status, putting it one step away from being labeled a "troubled institution."

At the same time, the OTS allowed IndyMac to make a major change in its books that kept it from insolvency.

Instead of continuing to carry more than $10 billion in loans that no investors would buy, it moved those loans to its "held for investment" portfolio.

Had it been forced to acknowledge that these loans were never going to be profitable, it would have had to report that its losses were more than six times larger than its operating capital.

"No honest regulator would permit a bank to cover that up, but OTS had become complicit with IndyMac," said William Black, a law professor at the University of Missouri at Kansas City and a former OTS attorney.

By the end of March 2008, more than half of all the bank's money was coming from loans it was getting from the federal government and short-term, high-interest deposits from middlemen called "brokered deposits."

The brokered deposits were so crucial to IndyMac staying in business that the bank fought hard to keep them coming.

In order to meet the threshold that allowed it to continue receiving brokered deposits, it lobbied the OTS to receive a waiver allowing it to remove certain costs associated with reverse mortgages from its books.

"I believe we have a lot of levers to pull and we will be a survivor of this period, but it is not guaranteed -- nothing in life is," IndyMac CEO Michael W. Perry wrote in an e-mail to employees on April 17, 2008. "I strongly believe that we retain our positive regulatory relationship with the OTS and it is in the FDIC's strong financial interest to work with us."

That same month, rating agency Standard & Poor's downgraded IndyMac's securitized mortgages and, at that point, the bank should have been declared short of cash, the inspector general said.

On May 6, the FDIC told OTS regional managers that IndyMac was close to failing and needed new money -- quickly.

"FDIC was very concerned," its spokesman Andrew Gray said. "And our analysis led us to a conclusion that IndyMac needed between $1 [billion] and $3 billion in additional capital to survive."

On May 9, IndyMac managers made this pitch to Darrell Dochow, the head of the thrift agency's western region: Let IndyMac accept an $18-million deposit from its holding corporation that day but book it as if it had occurred before the end of the first quarter.

In doing so, IndyMac would meet an important FDIC threshold and be allowed to accept more brokered deposits and high-interest retail deposits

Dochow agreed to IndyMac's proposal. The bank stayed "well capitalized" and was allowed to continue bringing in deposits for another two months.

In a Jan. 30 letter to Treasury Secretary Timothy F. Geithner, Reich said that IndyMac's independent auditors and the FDIC also knew about the backdating plan and "raised no objections."

FDIC officials countered that the agency had asked OTS about the late deposit and was told that IndyMac had a "note receivable," essentially a promise for the $18 million that had been given to it prior to March 31, 2008.

"That turned out to be misinformation," Gray said.

An IndyMac spokesman declined to comment.IndyMac, meanwhile, went fishing for more deposits. Its rate on a one-year certificate of deposit went from 2.35% in May to 4.05% in July. The average at the time was 2.45%. Shortly before being seized, it was offering 4.1% yield for a six-month CD.

Those rates alarmed the FDIC.

"We became concerned that the bank was paying interest rates which appeared to exceed the limitations prescribed in FDIC regulations applying to banks that were less than well capitalized," Gray said.

OTS, in its role as the lead examiner, could have stopped the bank from offering those high rates.

But IndyMac was allowed to bring in at least $90 million in new uninsured deposits from people like Hodgson, right before it collapsed.